3 ms·

"Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an inde

by rsync 9y ago

"Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performance or competency?" You don't have to look far to find this ... a great example is Restoration Hardware, which very recently borrowed money to buy back roughly half of the outstanding shares: "The move has caused the company to consume basically all of its available cash balances and debt to increase by $500 million. In consequence, stockholder's equity has swung from $920 million at the end of the company's last fiscal year into slightly negative territory."[1] This squeezed the shorts as well as (to the uninformed) bolstered their EPS dramatically as there are half as many shares now outstanding. Nobody but an industry insider or other market-specific trading desk would have any interest in a disaster of a stock like this, and yet RH is in the Russell 3000 and is therefore auto-purchased by savers and retirees everywhere. "if everyone is indexing, it surely must lose it's efficacy because it is no longer efficient, will indexing then not underperform?" This was explained, I think, very succinctly in the Dave Collum "year in review"[2] wherein he explains: "In his must-read book The Wisdom of Crowds, James Surowiecki posits that a large sample size of non-experts, when asked to wager a guess about something—the number of jelly beans in a jar, for example—will generate a distribution centered on the correct answer. Compared with experts, a crowd of clueless people offers more wisdom. I submit that this collective wisdom extends to democracies and markets alike. A critical requirement, however, is that the voting must be uncorrelated. Each player must vote or guess independently." And that is precisely the issue we are worried about facing with index funds - we are buying indexes so as to access the (real, efficacious) wisdom of the crowd. However, if nobody actually makes a best guess - if there are no participants in the "guess voting" the wisdom of the crowd is lost. [1] https://seekingalpha.com/article/4104757-shorts-restoration-hardware-get-squeezed-heels-strong-q2-earnings-increased-full-year https://seekingalpha.com/article/4104757-shorts-restoration-... [2] http://www.zerohedge.com/news/2017-12-23/dave-collums-2017-year-review-bubble-everything-grew http://www.zerohedge.com/news/2017-12-23/dave-collums-2017-y...

yborg 9y ago
The crowd's wisdom extends to the indexer. Another issue with these index-linked funds is that they create a single point of failure, i.e. the few people at Russell that curate the index. It would be very very easy for someone to, um, externally compensate an individual or two at Russell to include a dog in the index for the purpose of a massive stock pop. Similar to the bond-rating agency fiasco(s) leading up to the 2008 crisis. However, once an index is compromised like this, its overall returns will begin to suffer and people will move out of, say, Russell-linked funds. If it gets bad enough across the board, active-managed funds will begin to consistently outperform index funds and people will move their money there ... which presumably will rebalance the indexes. As far as I can see it, over the long term the system should self-correct.
- b4lancesh33t 9y ago
  It would also be pretty easy to spot something like that happening. If you see a stock in the Russell 3000 that is substantially less valuable than the distribution's tail would lead you to expect, then somebody is probably fucking with things. I would be astonished if Vanguard and other fund managers do not have automated monitoring to detect cases like this.
- Tehdasi 9y ago
  This is possible but unlikely. Bond rating agencies can more easily get away with mischaracterising "new and innovative" products than index funds can cheat investors. Index funds publish their methodology, and there is very little subjectivity (if any) in the application of these rules, that is after all, the point on an index fund. It would be far too easy to sue index funds if there were to defraud investors, and depending on the action and jurisdiction, criminal charges. Also if there was an issue with governance with index funds, going to a fund where governance is even more subjective would hardly seem to be an answer.
- givehimagun 9y ago
  I think you hit something right on the head. The index itself is defined by a formula that we generally agreed upon. We only need to have more choices of formulas...Russell is capitalization based - maybe that is too simple? Can we make a Hacker News 5000?

by rsync 9y ago

yborg 9y ago

The crowd's wisdom extends to the indexer. Another issue with these index-linked funds is that they create a single point of failure, i.e. the few people at Russell that curate the index. It would be very very easy for someone to, um, externally compensate an individual or two at Russell to include a dog in the index for the purpose of a massive stock pop. Similar to the bond-rating agency fiasco(s) leading up to the 2008 crisis. However, once an index is compromised like this, its overall returns will begin to suffer and people will move out of, say, Russell-linked funds. If it gets bad enough across the board, active-managed funds will begin to consistently outperform index funds and people will move their money there ... which presumably will rebalance the indexes. As far as I can see it, over the long term the system should self-correct.

b4lancesh33t 9y ago
It would also be pretty easy to spot something like that happening. If you see a stock in the Russell 3000 that is substantially less valuable than the distribution's tail would lead you to expect, then somebody is probably fucking with things. I would be astonished if Vanguard and other fund managers do not have automated monitoring to detect cases like this.
Tehdasi 9y ago
This is possible but unlikely. Bond rating agencies can more easily get away with mischaracterising "new and innovative" products than index funds can cheat investors. Index funds publish their methodology, and there is very little subjectivity (if any) in the application of these rules, that is after all, the point on an index fund. It would be far too easy to sue index funds if there were to defraud investors, and depending on the action and jurisdiction, criminal charges. Also if there was an issue with governance with index funds, going to a fund where governance is even more subjective would hardly seem to be an answer.
givehimagun 9y ago
I think you hit something right on the head. The index itself is defined by a formula that we generally agreed upon. We only need to have more choices of formulas...Russell is capitalization based - maybe that is too simple? Can we make a Hacker News 5000?